Germany Unveils €10B Tax Cut in Reform Package

Germany's CDU/CSU-SPD coalition under Chancellor Friedrich Merz unveiled a 34-point economic package on July 2, 2026, pairing income tax relief for low and middle earners with a higher top tax rate, longer fixed-term labor contracts, and the end of phone-based sick notes.

A €10 Billion Tax Cut Funded by Raising Rates on Top Earners

The package's centerpiece is €10 billion in income tax relief for low and middle-income earners, set to take effect January 1, 2027. The government plans to lift basic and child tax allowances, raise child benefits, and increase the employee lump-sum allowance. A working family with two children earning €60,000 a year would save up to €600 annually under the plan.

That relief is financed in part by raising the top income tax rate — Germany's so-called Reichensteuer — from 45% to 47% for earners above €280,000, while lowering the threshold at which the rate applies to €250,000. Inheritance and wealth taxes are untouched. On the business side, local tax offices will be legally required to issue tax numbers to new companies within four weeks, part of a broader push to cut bureaucratic reporting obligations for firms.

Sick Leave Documentation Returns to Paper From Day One

The package also ends employees' right to obtain a sick note by phone, a mechanism introduced during the pandemic era. Under the new rule, employees are required to submit a physical doctor's note starting on the first day of illness, and penalties for fraudulent sick leave claims will increase. The coalition frames the change as a response to persistently high sick-day volumes, though the raw package material does not specify a target reduction or timeline for measuring the policy's effect.

Fixed-Term Contracts Double in Length as the State Pension Age Holds at 67

On the labor-market side, fixed-term contracts issued without an objective reason can now run for up to 48 months and be renewed as many as six times — twice the previous legal limit — for workers hired through December 31, 2030. High earners will also gain more flexible dismissal-with-compensation arrangements. Separately, the flat-rate tax on so-called minijobs rises from 2% to 5%.

On pensions, the package confirms a gradual increase in the retirement age to 67 over coming decades and adds a capital-market-based component to the state pension system, built on the framework proposed by Germany's Old-Age Security Commission. The pension measure is scheduled for a Bundestag vote by late 2026. The government also outlined targeted growth support for the automotive, chemical, pharmaceutical, clean-tech, machinery, battery, semiconductor, and artificial-intelligence sectors, along with an expansion of the "Deutschlandfonds" investment vehicle into a resilience fund for energy and raw materials, and a plan to halve electricity grid expansion timelines.

The Bundesrat Hurdle Facing State Revenue Losses

The income tax changes — both the relief for low and middle earners and the higher top rate — reduce revenue that flows to individual German states, which means the measures require approval from the Bundesrat, the upper house of parliament representing state governments. That vote is described as a major hurdle still ahead, distinct from the pension overhaul, which the coalition is separately targeting for a Bundestag vote by late 2026.

The package arrives as the coalition faces pressure from the Alternative for Germany, which has been leading national polling ahead of regional elections in eastern Germany this September. Some economists have described the package as one of the largest German reform efforts in decades, and the coalition intends to move the primary elements through parliament by the end of 2026 — a timeline that assumes the Bundesrat vote succeeds.

The gap between those dates and dashed markers is deliberate: only the July announcement is confirmed. The pension vote, the regional elections, and the January 2027 tax changes are all forward-looking, and the tax provisions in particular remain contingent on the Bundesrat vote the coalition has not yet won.